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Economic overview

Nevertheless, Q2’s rebound did at least confirm that 2018’s woeful first quarter – which saw output shrink by 1.6 percent – was a weather-related blip rather than the start of a sustained slowdown.

This growth was also mirrored in the IHS Markit/CIPS Construction Purchasing Managers’ Index (PMI), with the index jumping to a 14-month high in July before settling back to a more modest level in September.

In part this uptick was the release of pent-up demand, as clients - who had been deferring investment decisions - opted to commit before the opportunity passed. This shift is underlined by our data which shows a rapid improvement in order books between Q1 and Q2.

Figure 1: Turner & Townsend contractor survey: Q2 2018

How full is your order book (percent) for each of the financial years

Economic data

Order books for the current financial year (2018-19) surged by 23.4 percentage points during Q2, while order books for the next financial year (2019-20) are now 17.5 percentage points fuller than they were in Q1. This is the fastest pace of quarterly growth since the survey’s inception in each respective period.

In addition, confidence is still fragile in many areas. Our contractor survey, which takes the temperature on the industry’s front line, found that in Q2 more than half of the UK builders surveyed felt the market will continue to cool over the next 12 months.

London contractors were the most bearish, with 26.8 percent of respondents in the capital predicting a cooling market. Worryingly, London is often a forward indicator for the regions, many of which have been outpacing the capital during the past 12 months.

The single greatest brake on confidence, and to a lesser extent activity, in the capital is Brexit uncertainty. London’s dominant financial sector exports its services internationally, and concerns that UK-based financial firms may see their trading relationships interrupted by Brexit have prompted many to consider relocating elsewhere in the European Union (EU).

Despite concerted marketing campaigns by Paris, Amsterdam and Berlin, Ireland’s capital has emerged as the most popular choice. According to EY’s financial services financial tracker, two in five companies have confirmed at least one relocation destination have selected Dublin.

This surge in interest has turbocharged Dublin’s already hot market, and it now risks overheating. Ireland’s construction sector still bears the scars from an economic boom and bust a decade ago, which was far more severe than Britain’s.

As a result Dublin is less ready for – and more wary of – the current surge in demand, with the city’s construction sector facing acute skills shortages and rapid price inflation.

National tender price inflation

The data shown above is representative for the UK as a whole and costs may vary substantially between regions. For further assistance on cost assurance and inflation analysis in your area, please contact Turner & Townsend.

Regional tender price inflation

A tale of two Brexits

They’re less than 300 miles apart, but the gulf between the fortunes of London and Dublin is growing.

With Britain’s post-Brexit future still far from settled, investor uncertainty is holding back both output and sentiment in London’s once buoyant construction market.

By contrast, Dublin is in the midst of a full-scale boom, with bullish sentiment and strong client demand driving up tender prices at well over double the rate seen in Britain’s capital.

The gap between the two is at its most stark when you compare levels of sentiment. Our latest contractor survey – which takes the temperature on the front line of the industry – saw nearly two thirds (63.6 percent) of respondents in Dublin say they felt their market is improving and getting warmer.

That’s three times the level of optimism recorded in London, where just 21.1 percent of respondents felt their market is warming, and 26.8 percent said they expected the London market to cool.

But if the two markets are each in a different place now, the routes they have taken to get there are poles apart.

Figure 6: Turner & Townsend contractor survey: Q2 2018

Is the construction market getting warmer, cooler, or staying the same?

Proportion of respondents indicating the construction market is getting warmer

Dublin’s dive… and rise

Dublin’s crash in the wake of the Global Financial Crisis was vertiginous, and lasted much longer – and cut much deeper – than London’s.

Yet since the Brexit referendum in June 2016, Irish construction output has accelerated sharply, rocketing by almost a third (27.7 percent) in less than two years, between Q2 2016 and Q2 2018.

By contrast, UK construction output rose by only 8.1 percent during the same period. In the first quarter of 2018 it even fell by 1.6 per cent on the level seen a year before, before posting positive quarterly growth of 0.8 percent in Q2 2018.

Figure 7: Construction employment levels in London and Dublin

Ireland’s surge in output has been underpinned by an equally dramatic surge in hiring. In the six years from Q1 2012 to Q2 2018, levels of construction employment in Dublin almost doubled, rising by 86.9 percent. In London they rose, but much more modestly, by 12.5 percent.

Anecdotal evidence suggests that in a post-Brexit UK, freedom of movement restrictions may amplify labour shortages. Whereas, by comparison, it could be easier for Irish construction firms to recruit workers from other EU countries.

But the real reason Irish firms have managed to hire so intensively without a simultaneous surge in labour cost inflation is a legacy of the pain of Ireland’s recession; spare capacity.

Figure 8: UK and Republic of Ireland unemployment rate (percent)

Unemployment in Ireland peaked at 16.0 percent during its recession, nearly double the rate recorded in the UK. Despite falling sharply as the Irish hiring boom gathered pace, it remains well above the UK’s unemployment rate – which dipped to 4.0 percent in June 2018. This is its lowest level for more than four decades.

Sunshine on the Liffey

On the demand side, Irish construction firmsare enjoying a moment in the sun too.

Our contractor survey found nearly three quarters (72.7 percent) of construction firms in Dublin see tendering conditions as either warm or overheating – with buoyant client demand and lower levels of competition between contractors forcing up tender prices.

Meanwhile in London, more than half of contractors (54.9 percent) rated tendering conditions in the UK capital as lukewarm, as anaemic demand and brisk competition for work obliges contractors to keep tender prices in check.

Dublin contractors predicted their tender prices would rise by an average of 6.3 percent in 2018, while those in London forecast a modest 2.5 percent uptick. Contractors on both sides of the Irish Sea also see little prospect of the tables turning in coming years.

Figure 9: Turner & Townsend contractor survey: Q2 2018

How much (percent) do you think tender prices will increase or decrease in 2018, 2019 and 2020?

Threat rather than reality

Brexit’s opponents are quick to attribute the two cities’ diverging fortunes to a flight of capital from London to Dublin.

But while there have been some high-profile examples of financial sector giants swapping the City for the Liffey, for now the exodus remains more threat than reality – even if many of London’s leading players have drawn up relocation plans just in case.

Clearly it is nonsense to suggest that the interplay between the two is a zero-sum game, and that Dublin’s market is heating up in direct inverse proportion to London’s cooling.

Even before the Brexit referendum crimped demand in the UK, Ireland was at an earlier stage than Britain in its economic recovery, with further to run on its upcycle.

Nevertheless Brexit clouds are not unknown on the western side of the Irish Sea. Ireland’s economy is closely linked to that of its larger neighbour, and it would thus be highly exposed to the fallout of any post-Brexit contraction in the UK.

But for now, with the final terms of the Brexit deal – let alone the economic prospects of a non-EU Britain – still far from clear, the issue for both countries remains primarily one of uncertainty.

The difference between the two is how that uncertainty is playing out. Our researchers asked contractors in both Dublin and London to rate the impact a series of supply challenges are having on their ability to deliver projects.

While more of the London cohort than their Dublin counterparts felt they were being adversely impacted by two systemic factors – real estate market oversupply and insufficient availability of credit – the contrast was much more polarised when it came to more obviously Brexit-related issues.

Responses showed that London contractors felt their wings were being clipped by both political instability and clients’ lack of confidence, while in Dublin the perceived impact of these issues was much lower.

In other words, while Brexit itself will cause ripples on both sides of the Irish Sea, for now the uncertainty of the Brexit countdown is taking a far greater toll in London than in Dublin.

Figure 10: Turner & Townsend contractor survey: Q2 2018 Please identify the extent of how the listed challenges have impacted your business in the past quarter

Please identify the extent of how the listed challenges have impacted your business in the past quarter 1 = Little impact 5 = Major impact

Different markets, different opportunities

While much of London’s pain can be traced back to a single, primary cause – Brexit uncertainty – the symptoms are varied and complex.

Scrutiny vs engagement

In challenging markets like London, clients must face down multiple, fast-moving threats with equally agile procurement and project management strategies.

The most obvious issue to be confronted is supply chain strain. Ever since the EU referendum of 2016, contractors in London have found themselves in a painful double-bind. Cooling investor demand has forced them to bid low for work - squeezing already tight margins – and the long-term skills shortage has been exacerbated by the shrinking pool of EU workers.

At best, such strains limit supply chain capacity. At worst they expose clients to the risk that contractors could slide into insolvency halfway through a project.

Such risks mean clients must remain vigilant. In practical terms, this means re-running credit checks and challenging suppliers on their ability to continue delivering, while also seeking to understand and allay their concerns.

However, it’s important to strike the right balance between supply chain scrutiny and engagement. Clients should put an arm round their suppliers while simultaneously keeping their eyes peeled for any sign of weakness.

Supply chain engagement is equally important – but for different reasons – in hot markets like Dublin. Where client demand is strong, it’s essential for clients to establish right at the start of the tender process that contractors truly want their work, and are not bidding speculatively.

In such markets two-stage tenders are more common. Against a backdrop of rising tender prices like those seen in Dublin, clients should consider using alternative risk strategies to the conventional two stage model. Thus making sure they are always in control and avoid being caught out by large price hikes prior to getting the main contractor in contract.

In addition they should engage regularly with their contractors. This means listening to their views on procurement routes, unacceptable risk transfer, and unrealistic deadlines – and relay this feedback to their project teams.

The overarching goal should be to foster collaboration across the supply chain. Sharing intelligence through capacity studies, and agreeing common approaches to contract risk. These are both effective ways to increase cooperation while also managing the risks posed by input cost inflation and price escalation.

Contract management

Another area where there is a clear dividing line between best practice in London and Dublin is contract management.

With Dublin’s contractors enjoying buoyant workloads, tenderers are more likely to push back on what they deem to be unacceptable conditions, such as unlimited liabilities or high levels of Liquidated Ascertained Damages (LADs).

Equally, once a pre-construction appointment is in place, contractors in such circumstances are likely to reject client amendments that might impair their future borrowing prospects. This may also affect project administration and cashflow.

For this reason, clients in Dublin should consider carefully before requesting amendments and insertions. As a rule, the best course is to include what is necessary but without pushing for all the ‘nice to haves’. Failure to do so could trigger cost increases, as in a strong economic climate tenderers will add price for risk, greater liability or more onerous requirements.

For clients in London, the position is more stark. In normal times, contracts offer protection for both clients and suppliers, as a bulwark against unpleasant or unexpected change.

However the extreme uncertainty triggered by Brexit – in particular the prospect of the UK crashing out of the EU with no deal – raises the prospect of certain contractual agreements being invalidated.

Clients should consider conducting a contract health check on their baseline cost, scope, risk and schedule to give advance warning of where their risk lies. By also identifying where the supplier’s risk lies, such testing will also provide the client with a powerful lever for negotiation in the event of a dispute.

By the same token, clients investing in an uncertain market will need to have robust project controls in place. Used correctly, controls serve a twin purpose – as both a guarantor of efficiency and an early warning system.

With the eventual impact of Brexit still unknown – and unknowable – clients in London should dial up the levels of scrutiny on all aspects of their projects.

In many cases this will mean using existing control tools more intensively; for example holding fortnightly rather than monthly progress meetings.

Those who seize this opportunity to revisit their project baselines could increase the robustness of their project controls and performance management systems – providing reassurance whether they identify issues or not.

Shared fortunes, tailored solutions

The growing divergence between the markets in London and Dublin means each offers a distinct set of challenges and opportunities.

In London, modest tender price inflation and high levels of contractor competition can make it appear a client’s market. With some clients deferring investment decisions until there is greater clarity on Britain’s post-Brexit future, those who are committing to build frequently opt for single-stage tendering in an effort to transfer project risk to the supply chain.

While this approach is outwardly attractive for clients, single stage tenders can heap additional stress on contractors. In the current atmosphere of fragile, strained supply chains, the wisdom of such an aggressive approach is questionable.

Far better then for London clients to focus on working collaboratively with their contractors – albeit with robust project controls – and to tender intelligently, ensuring risk is distributed fairly between themselves and the supply chain.

By contrast, tendering conditions in Dublin are being played by different rules. Strong demand has emboldened contractors to push back against single stage tenders, and price escalation is a key project risk for clients.

For this reason, clients in Dublin should engage early with their suppliers to give themselves the best chance of understanding and controlling risk. Good knowledge flow across the supply chain is crucial too, as is intelligence sharing and timely supplier participation in strategic decisions – all of which can boost collaboration and manage project risk.

It’s fanciful to think of London’s loss being Dublin’s gain. The Irish and UK economies remain closely linked and will continue to do so after Brexit. The sheer size of the London market still dwarfs that of Dublin’s, and a smooth Brexit could soothe UK investors’ nerves and unlock a surge of previously mothballed development plans.

Meanwhile Dublin – no stranger to booms of its own – should learn from London’s experience to ensure the current spike in demand does not trigger runaway inflation.

As the final countdown to Brexit begins, diverging conditions in the two capitals are throwing up differing threats and opportunities. To survive and thrive in either city, clients need world-class, adaptive and data-led advice.